Revealed Preference

Revealed preference is an economic theory of consumption behavior which asserts that the best way to measure consumer preferences is to observe their purchasing behavior. Revealed preference theory works on the assumption that consumers have considered a set of alternatives before making a purchasing decision. Thus, given that a consumer chooses one option out of the set, this option must be the preferred option. The theory allows room for the preferred option to change depending upon price and budgetary constraints. By examining the preferred preference at each point of constraint, a schedule can be created of a given population's preferred items under a varied schedule of pricing and budget constraints.

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For a long time, consumer behavior—most notably consumer choice—had been understood through the concept of utility. In economics, utility refers to how much satisfaction or pleasure consumers get from the purchase of a product, service, or experienced event. However, utility is incredibly difficult to quantify in indisputable terms, and by the beginning of the 20th Century, economists were complaining about the pervasive reliance on utility. Replacement theories were considered, but all were similarly criticized...until a theory offered by American economist Paul Anthony Samuelson in 1938. His "Revealed Preference Theory" posited that consumer behavior was not based on utility—but on observable behavior that relied on a small number of relatively uncontested assumptions. As economists developed the theory, they identified three primary axioms of revealed preference: the weak axiom, the strong axiom, and the generalized axiom.

Weak Axiom

This axiom states that given incomes and prices, if one product or service is purchased instead of another, then, as consumers, we will always make the same choice. The weak axiom also states that if we buy one particular product, then we will never buy a different product or brand unless it is cheaper, offers increased convenience, or is of better quality, i.e. unless it provides more benefits. As consumers, we will buy what we prefer and our choices will be consistent, so suggests the weak axiom.

Strong Axiom

This axiom states that in a world where there are only two goods from which to choose, a two-dimensional world, the strong and weak actions are shown to be equivalent.

Generalized Axiom

This axiom covers the case when, for a given level of income and or price, we get the same level of benefit from more than one consumption bundle. In other words, this axiom accounts for when no unique bundle that maximizes utility exists.

The original intention of revealed preference theory was to expand upon the theory of marginal utility, coined by Jeremy Bentham. Utility, or enjoyment from a good, is very hard to quantify, so Samuelson set about looking for a way to do so. Since then, revealed preference theory has been expanded upon by a number of economists and remains a major theory of consumption behavior. The theory is especially useful in providing a method for analyzing consumer choice empirically.

The theory states that given a consumer's budget, they will select the same bundle of goods (the "preferred" bundle) as long as that bundle remains affordable. It is only if the preferential bundle becomes unaffordable that they will switch to a less expensive, less desirable bundle of goods.

As an example of the relationships expounded upon in revealed preference theory, consider consumer X that purchases a pound of grapes. It is assumed under revealed preference theory that consumer X prefers that pound of grapes above all other items that cost the same, or are cheaper than, that pound of grapes. Since consumer X prefers that pound of grapes over all other items they can afford, they will only purchase something other than that pound of grapes if the pound of grapes becomes unaffordable. If the pound of grapes becomes unaffordable, consumer X will then move on to a less preferable substitute item.

Some economists say that revealed preference theory makes too many assumptions. For instance, how can we be sure that consumers’ preferences remain constant over time? Isn’t it possible that an action at a specific point in time reveals part of a consumer’s preference scale just at that time?

For example, if just an orange and an apple were available for purchase—and the consumer chooses an apple—then we can definitely say that the apple is revealed preferred to the orange.

There is no proof to back up the assumption that a preference remains unchanged from one point in time to another. In the real world, there are lots of alternative choices. It is impossible to determine what product or set of products or behavioral options were turned down in preference to buying an apple.